Sunday, March 17, 2013

The Eurogroup announcement on Saturday of an agreement with the Cypriot authorities for a macroeconomic adjustment program came with a big surprise. The agreement involves a controversial "one-time-tax" on bank deposits. The tax is progressive starting with a lower level for bank deposits below 100k Euros. While the authorities are trying to sell this measure as a tax, it is clearly going to be read as a statement that regardless of any deposit insurance mechanism (which is in place in Cyprus for deposits below 100k), bank deposits might now be considered risky. As much as the Eurogroup and the Cypriot authorities will do their best to minimize this interpretation, there is the possibility that it spreads to other countries and that we see bank runs at a significant scale in some of them.

The reaction to the announcement has either been of hope or panic. My reaction is somewhere in between the two.

When it comes to the government of Cyprus, they are hopeful that everyone will understand that this was a one-time event and that the country can now move forward. From CNBC here is a quote from the Cyprus finance minister Michael Sarris:

"Absolutely, there is no capital restrictions, people can move. We hope people will believe us, believe the collective leadership of the European Union, that this was a necessary step, but a single shot at the problem, and that from now on they can be very confident that nothing will happen to their savings."

This will not happen, people will not believe them (not to mention the fact that the parliament has postponed the approval of the agreement that was scheduled to happen on Sunday). Prepared for several rounds of panic. I doubt the banking system will be able to operate without some capital restrictions over the coming days.

On the other side, there are those who panic that this is the prelude of bank runs in Greece, Spain, Portugal or Italy. This is certainly a possibility and we have already seen withdrawals of deposits in some of these countries during this crisis, but it will take a lot of panic to produce a significant bank run. The reason is that there are still costs or barriers to produce a widespread bank run in these countries. The assumption that all the depositors in these banks will immediately open an account in Germany and transfer all their funds is (fortunately) not obvious. There are significant restrictions in opening of bank accounts even within the Euro area if depositors do not have residence in the country where the bank is established. Of course, there is always the option of hiding all your deposits under your mattress (or a cash vault) but both they represent a risk or they simply are not practical enough. Having said that, in the event where there is a strong perception that a similar "one-time-tax" is about to happen in other countries, these barriers will not be enough, so a bank run cannot be ruled out either.

The next days are going to test the ability of European authorities to convince the public that what has happened in Cyprus will not happen in other countries. Is it possible? Yes, this is what to some extent happened after the agreed default on Greek government debt. The fact that interest rates on government debt of other countries in the periphery has come down significantly over the last months is a proof that you can credibly claim that certain events are exceptional and will not spread. Contagion is always possible when we see default but it is not always necessary. Let's see how good European authorities are this time to ensure that hope defeats panic.

Antonio Fatas

I am the Portuguese Council Chaired Professor of European Studies and Professor of Economics at INSEAD, a business school with campuses in Singapore and Fontainebleau (France), a Senior Policy Scholar at the Center for Business and Public Policy at the McDonough School of Business (Georgetown University, USA) and a Research Fellow at the Center for Economic Policy Research (London, UK).